Opportunities For High Yields Abound In Asia – Capture Them With Eastspring Investments

2018 has not been a good year for Asian High Yield investors who went into the bond market in mid-January when spreads were unfavourably low.

From a sentiment standpoint, it is understandable if you are still on the side lines given the ongoing subdued investor appetite in both equity and fixed income markets.

You may also be wary about the risks involved investing in high yielding Asian bonds especially with how the rise in yield has been a reflection of an increase in defaults coming from China’s onshore bond markets.

Our views on this fixed income segment, however, remains positive as we have previously outlined in this article. 

Hence, we think this would be an opportune time to highlight an interesting fund to you as it has some discerning attributes which may help to address some of your pressing concerns.

At the same time, we will also be answering some of the burning questions you may have about this fixed income segment in turn.

How has the performance of Asian High Yield fared thus far?

Since the last time we spoke about Asian High Yield back in July, the fixed income segment has pared some of its previous losses, bringing its year-to-date returns to ~1.2% as of end-October. Not too bad for an asset class that has been under pressure from negative news cycle surrounding trade-related tensions and deleveraging in China.

Chart 1: Indexed erformance of Asian High Yield versus Global Bonds

Yields have risen across the board in the fixed income realm as it reflects the rising interest rate environment we are currently in. Unlike before, investors now demand a higher level of return in exchange for taking on risks. However, the increase in yield demanded by investors differ for the various fixed income segments, with the riskier segments taking in a lion’s share of it. As of end October 2018, Asian High Yield now offer investors one of the highest yields available in the fixed income market.

Chart 2: Yields have risen across the board with some more than others

Is this the right time to invest in the Asian High Yield segment?

In the face of volatility, investors often find it counter-intuitive to invest into Asian High Yield as it is deemed to be the riskier segment of fixed income markets. However, given that valuations (as measured by the risk premium) are significantly more attractive now, investors are better rewarded for the risk they undertake.

Even if spreads continue to widen, investors can still benefit from a higher margin of safety achieved from the higher levels of yields they lock-in today. We believe the additional yield pickup of ~270 bps since the beginning of the year will provide sufficient cushion for investors from interest rate risks.

Ultimately, the risk you undertake for investing in Asian High Yield (or any form of investments for that matter) largely depends on the price levels you buy into. Considering that fundamentals have not turned significantly for the worse, buying into Asian High Yield right now when valuations are cheap reduces downside risks to your investments.

We also think that the ability to sieve out credit-worthy names from the less credit-worthy ones in such an environment (as described earlier) grows in importance. Therefore, we think it is ripe to look at Eastspring Investments – Asian High Yield Bond Fund in greater detail, at a time when the ability to find a balance between yield and risk may provide an edge to your portfolios.

How can we gauge the credit selection capability of Eastspring Investments – Asian High Yield?

One way to gauge the credit selection ability of the bond funds is to view their year-to-date performance when spreads began to widen, since good credit selection ability should translate into strong fund performance.

Chart 3: Year-to-date performance of comparable Asian High Yield funds

While Eastspring Investments – Asian High Yield Bond Fund netted ~1% year-to-date loss after a volatile 2018, its performance exhibits lower volatility than its peers, largely owed to the fund’s defensive positioning it had in place since the end of 2017 when credit spreads were narrow. In mid-2017, fund sported a lower yield, and higher duration, suggesting a more defensive positioning in terms of credit selection for its portfolio.

However, seeing how yields have risen to attractive levels once again, the fund’s is now taking on a higher risk-on positioning, as indicated by its gradual shift towards higher yield and lower duration relative to benchmark, to capture the higher yields offered by the market.

Table 1: Fund yield-to-worst and average duration relative to the benchmark

We believe the fund’s adherence to investing in credits that have stronger risk-reward outcomes, such as the approach to go more risk-on when yields are favourable, will pay off over time as it reduces downside risks for your investments.

Besides credit selection, is there any other indicator that may suggest the fund’s ability to weather any further temporary weakness in market sentiment?

It is important for a fund to be adequately diversified in an environment when default risks is an important worry for investors. Funds with lower levels of issuer concentration will naturally be less exposed as the portfolio’s AUM is spread across a larger pool of securities. Thus, the ability to be nimble is one important factor that may provide some insight on what a fund can do to limit risks.

While it is safe to assume that all bond fund managers active manage risks as best as they can, what they can do are often limited by the AUM of their portfolio as well as the individual position size of the underlying bond holdings.  One way to gauge how various funds are equipped to manage risks is to look at their AUM per security ratio.

Table 2: Eastspring Investments – Asian High Yield has the advantage of being more nimble than its peers

Compared to its peers, Eastspring Investments – Asian High Yield Bond Fund exhibits a lower AUM per security. With a smaller AUM size, Eastspring Investments – Asian High Yield Bond Fund has the advantage of being more nimble than other Asian High Yield funds in a USD 200b fixed income universe where large holdings may take longer to divest and potentially result in significant price impacts.

What has detracted from Eastspring Investments – Asian High Yield Bond Fund's performance?

Foreign exchange fluctuations has been the main detractor (-67.41 bps) for Eastspring Investments – Asian High Yield Bond Fund’s year-to-date performance. The fund manages a small amount of local currency exposure which have negatively impacted on overall fund performance, due to sizable volatility seen in the rupee and rupiah.

Chart 4: Rupee and Rupiah have been on a downward spiral against the USD in 2018

However, if we strip out the effects of foreign exchange on the fund’s performance, the fund holds up quite well relative to its peers.

Chart 5: Currency effect has been the main detractor of the fund’s year-to-date performance

The main reason behind the increase in local currency exposure for IDR and INR towards the end of 2017 was due to the decision of reducing exposure to hard currency Indonesian and Indian bonds when valuations were deemed expensive. Instead, the manager shifted some allocations into local currency investment-grade credits but has been unfortunately punished by currency volatility thus far. Nonetheless, the fund’s currency underperformance could set the stage for future portfolio outperformance when the rupee and rupiah stabilise against the dollar.

When choosing Asian High Yield funds to invest in, should I just go for the highest yielding ones?

Investors should not simply jump at any funds offering the highest yields as more is not necessarily better. This concept applies to investments in general and not just for investing within Asian High Yield.

Since default probability is reflected in credit spread levels, going for higher yielding securities simply means that you are willing to take on higher credit risks which may not be palatable to some investors.

Although investing in credits with stronger fundamentals would equate to lower yields, investors will in return, get to enjoy lower drawdowns and volatility, and hence lower risk of capital loss. Eastspring Investments – Asian High Yield Bond Fund’s philosophy of prioritising credit fundamentals over yields will therefore be appropriate for risk-aware investors.

Chart 6: Yield and duration of Eastspring Investments – Asian High Yield Bond Fund and its peers

The fund recently increased dividend pay outs equivalent to 7.0% p.a. to unit holders which should still be highly appealing to investors who require a decent level of income.

Speaking of defaults, has Eastspring Investments – Asian High Yield Bond Fund experienced any so far?

As mentioned earlier, the hard currency Asian High Yield bond market had experienced a series of defaults over the past few months, with many coming from Chinese issuers.

Chart 7: Defaulted hard currency issues from China have been on the rise in 2018

Fortunately, Eastspring Investments – Asian High Yield Bond Fund has a low historical default of 0.04% since inception. It has yet to record any this year, which is commendable given the relatively challenging backdrop for Asian High Yield thus far.

An issuer the Eastspring Investments – Asian High Yield Bond Fund actively avoided was China Sinyes Solar Technologies, a company that recently defaulted on its redemption on 17 October 2018. The fund’s investment team believed that the risks associated with investing in this bond issue was high relative after considering the company’s credit fundamentals.

Furthermore, the default the fund has had arose from a single technical default. This means that the credit event did not arise from a failure of the bond issuer to make debt repayment. But rather, the issuer merely breached certain thresholds outlined in the loan agreement with bondholders. Eventually, bondholders still got most of their money back.

I’m still uneasy with the large proportion of holdings into China, are there any other options for Asian High Yield?

China’s economic clout means that a large proportion of Asian High Yield exposure will inevitably originate from Chinese issuers. Investors who are not sanguine about the long-term outlook of China, preferring not to have any exposure to the single-country market, certainly have the prerogative to exercise their investment views.

But they should be aware that by doing so, they are effectively removing themselves from a world of opportunities. Investors must be aware of the opportunity costs from not participating in its growth story. Furthermore, they are also unlikely to find any Asian equity or fixed income unit trusts without China as a major component in their portfolios.

It is inevitable that investors will be met with brief moments of market uncertainty as we are seeing today. However, with a longer time horizon and a disciplined attitude to investing, riding out the volatility is part and parcel of investing.

Asian High Yield is one fixed income segment investors should not quickly dismiss, as it is currently attractive from a risk to reward perspective. If you are an income seeker looking to achieve a decent yield of 7.0% p.a. for your portfolio, we believe Eastspring Investments – Asian High Yield Bond Fund is one fund that you should certainly consider.

The Research and Portfolio Management Team is part of iFAST Financial Pte Ltd.